Question

On December 31, Year 6, Ultra Software Limited purchased 70,000 common shares
(70%) of a major competitor, Personal Program Corporation (PPC), at $30 per
share. Several shareholders who were unwilling to sell at that time owned the
remaining common shares and the preferred shares.
The preferred shares, which are non-cumulative, are entitled to a $12 divi-
dend. Each is convertible into two common shares. Immediate conversion of these
preferred shares has been, and will continue to be, highly unlikely due to the cur-
rent market conditions for the shares. Management is concerned, however, about
the effect that any future conversion would have.
At December 31, Year 6, PPC’s net assets had a carrying amount of $1,525,000.
The identifiable assets and liabilities had carrying amounts equal to fair values,
with the following exceptions:
• Software patents and copyrights had a total market value estimated as
$300,000 above carrying amount. These were expected to have a five-year use-
ful life.
• Inventories of packaged software had a cost to PPC of $20,000 and an esti-
mated selling price of $140,000. Estimated future selling expenses for these
items were $15,000.
• An unrecorded brand name had an estimated fair value of $2,375,000. This
will be amortized over 40 years.
• In determining the purchase price, the management of Ultra noted that PPC
has two years remaining on a long-term contract to supply seats to a major
car manufacturer. Given the rapid rise in input costs, PPC earns a negative
gross margin on this contract. An independent appraiser indicated that the
fair value of this unfavourable supply contract is a negative $500,000.
The trial balances at December 31, Year 8, for these two companies are pro-
vided as Exhibit IV .

In Year 7, PPC sold packaged software costing $30,000 to Ultra at a price of
$45,000. Of this software, 60% was still in Ultra’s inventory at December 31, Year
7. During Year 8, packaged software costing $42,000 was sold by PPC to Ultra for
$60,000. Ultra’s inventory at December 31, Year 8, included $22,000 of goods pur-
chased in this sale. Neither of these packaged software inventories sold to Ultra
had a fair value difference at acquisition.
Goodwill is tested for impairment on an annual basis. Each year, it was deter-
mined that goodwill was not impaired.
Included in the Year 8 income of PPC was a gain of $50,000 on the sale of pat-
ents to another company. This sale took place on June 30, Year 8. These patents had
a fair value difference of $20,000 at acquisition.
On September 30, Year 8, Ultra sold surplus computer hardware to PPC. This
equipment had a cost of $6,000,000, was one-half depreciated, and was sold for its
fair value of $2,000,000. Disassembly and shipping costs of $80,000 were paid by
Ultra. There was estimated to be a nine-year remaining useful life in its new use.
Preferred dividends were paid in all years, and no new shares have been
issued since the acquisition date.
Assume a 40% tax rate.
Required:
(a) In accordance with GAAP, prepare the following:
(i) Consolidated income statement for the year ended December 31, Year 8.
(ii) Consolidated statement of retained earnings for the year ended Decem-
ber 31, Year 8.
(iii) Schedule showing the values of the following consolidated balance sheet
accounts as at December 31, Year 8:
(1) Software patents and copyrights
(2) Packaged software inventory
(3) Non-controlling interest
(b) Write a brief note to the management of Ultra outlining the financial reporting
implications in the event that the preferred shareholders of PPC exercise their
conversion privilege.